Standard II(A): Material Nonpublic Information
If you hold information that is both material (likely to move the price, or something a reasonable investor would want) and nonpublic (not yet made available to the market), you must not act on it or cause anyone else to. Reaching a conclusion from public facts and nonmaterial nonpublic details (the mosaic theory) is allowed.
Before this: Standard I(E): Competence
On the exam
- Demonstrate the application of the Code of Ethics and Standards of Professional Conduct to situations involving issues of professional integrity
- Recommend practices and procedures designed to prevent violations of the Code of Ethics and Standards of Professional Conduct
- Identify conduct that conforms to the Code and Standards and conduct that violates the Code and Standards
The most tested Standard. Demonstrate II(A), recommend procedures and identify compliant conduct. Expect "material and nonpublic?" vignettes, mosaic-theory items and "what should the analyst do?" (do not trade, encourage public disclosure, tell compliance).
How deeply to learn each part
- Know the idea
- Understand it in general. It frames other topics, but you will not calculate with it.
- Use it
- Understand it well enough to solve a question with it. Recognize when it applies.
- Memorize
- Learn it by heart. The exam will not give it to you.
You know this one. The full lesson is folded away. The takeaways, formulas and checkpoint below are your quick refresher, and the checkpoint is a fair test of whether you still do.
You tested strong here. The full lesson is folded away. The takeaways, formulas and checkpoint below are your quick refresher, and the checkpoint is a fair test of whether you still know it.
What does Standard II(A) require?
Members and candidates who possess material nonpublic information that could affect the value of an investment must not act, or cause others to act, on it. The Standard has two tests, and both must be met before it applies.
Memorize
- Material. Materiality turns on the likely effect on price, or on whether a reasonable investor would want the information before deciding. Specific, reliable information from a source with first-hand knowledge (a company insider, the staff running a drug trial) is more likely material. Speculation by an outsider is less so, and so is information whose effect on price is unclear.
- Nonpublic. Information stays nonpublic until it has been made available to the market in general. Sharing it on a briefing call for analysts, or with a handful of investors, does not make it public. Once it is widely distributed, for example by a press release or a filing, it is public and II(A) no longer applies.
- Do not act or cause others to act. That bans your own trades, tipping others and quietly changing a recommendation because of what you know.
- Material and nonpublic Memorize both gates open
- Do not act or cause others to act no trades, no tips
- Encourage public disclosure then tell compliance if it cannot be made public
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- Material but public Memorize already disseminated
- Free to use II(A) no longer applies
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- Nonpublic but not material Memorize small details
- Mosaic theory may be combined with public facts into a conclusion
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Exam tip Ask two questions in order: is it material, and is it nonpublic? A “no” to either ends the problem. A “yes” to both means freeze.
What if you receive it?
Your first duty is to leave the information alone. Make reasonable efforts to bring about public dissemination , usually by encouraging the issuing company to announce it. If that is not possible, pass it only to your firm’s supervisory and compliance staff, and do not trade or change a recommendation on it. Do not knowingly do anything that could induce insiders to leak.
There is a narrow exception: information given legitimately by a company for a defined purpose, such as due diligence on a merger, a loan, a credit rating or an offering, may be used for that purpose. It cannot be used to trade.
How does the mosaic theory work?
Analysts are paid to find what the market has not yet worked out. Under the mosaic theory , you may build a conclusion from public information plus nonmaterial nonpublic information, even if the same conclusion, heard straight from an insider, would be material nonpublic information. No single piece is material and nonpublic, so there is nothing to act on illegally.
Go deeper Why keep records of a mosaic
Evidence that you held only public and nonmaterial pieces supports the claim that you reached your view by legitimate analysis rather than from inside information. Standard V(C) on record retention is the reason to save the research trail.
Where do the lines fall?
| Situation | Material? | Nonpublic? | Verdict |
|---|---|---|---|
| A finance chief tells you over dinner that next quarter’s sales will miss guidance by 25% | Yes | Yes | Do not trade or tell; encourage disclosure |
| You combine shipping data and store visits and downgrade a retailer | Conclusion yes; pieces no | Pieces public or nonmaterial | Fine: mosaic theory |
| An anonymous rumor on a chat forum | Unlikely (unreliable) | Public | May consider, with care |
| Your firm’s banking team is advising on an unannounced merger | Yes | Yes | Firewall; watch or restricted list |
| An expert network contact reveals an unreleased trial result | Yes | Yes | Stop; do not trade; tell compliance |
Try this 0 of 3
- Clear all five cases right first time
- Rule on the private call right first time
- Clear the mosaic right first time
Case 1 of 5 The CFO dinner
Tomás Reyes, CFA, is an analyst at Halden Park Capital and covers Corvane Foods, which Halden Park's funds own. Over dinner, Corvane's chief financial officer tells him that next quarter's sales will come in about 25% below guidance. Corvane reports results in three weeks and has announced nothing. Back at the office, a portfolio manager asks Tomás whether the funds should still hold the stock.
Step 1 of 5 Gate 1: Material?
A 25% sales miss, told to him by the company's own CFO. Is it material?
Read the case, then answer each step. 5 cases.
What about experts, social media and research reports?
- Industry experts. The Standard allows you to consult industry experts and expert networks and to pay them for their insight. You remain responsible for not asking for, or acting on, confidential information. If an expert gives you material nonpublic information, you may not act on that company until it becomes public, whatever agreements the network had in place.
- Social media. Information in closed groups may not be public. Check that material information can also be found in a public source before relying on it.
- Research reports. A well-known analyst’s recommendation can move the price. It is built from public information and the analyst’s own work, so it does not have to be made public to everyone. Non-clients can do the work themselves or become clients.
How do firms prevent misuse?
Firms should adopt compliance procedures, and the main control is a firewall , an information barrier that limits confidential information to those who need it. Its core elements, together with the separation rules that make it work, are shown below.
Memorize
- Compliance clearance Memorize cross-department communication goes through compliance or legal
- Lists Memorize watch, restricted and rumor lists to review employee trading
- Physical separation Memorize banking away from sales and research
- No personnel overlap Memorize an employee is on one side of the wall at a time
- Documentation and proprietary trading review Use it record the controls; restrict firm trading while holding inside information
Lists matter for the exam. A watch list and restricted list work differently. A security goes on the restricted list when the firm has, or may have, material nonpublic information about it, and employee trading in it is restricted. Because a widely circulated restricted list can itself tip people off, firms also keep a watch list that only a few compliance staff see and use it to monitor trading quietly. A rumor list tracks unconfirmed talk. Anyone who must cross the wall consults compliance first.
Members should also encourage disclosure policies under which companies give every analyst the same information, whatever the size of the analyst’s firm. Inside investment firms, new or changed recommendations should reach all clients fairly.
Go deeper Why a banker-analyst cannot go back to research
An analyst lent to the banking side for a deal becomes an investment banker until what they learned is public. They cannot use it for research or share it with research colleagues. Inside knowledge is not limited to the deal itself: product plans and budgets seen during the project count.
Go deeper Why this protects market integrity
Markets work when investors trust that nobody is trading on a secret advantage. This is the Code’s market-integrity principle. Insider trading laws vary, but the Standard applies regardless of whether the local law has caught up, and I(A) means you follow the stricter rule.
Memorize this
MemorizeStandard II(A): the two gates
| Gate | Information passes if | Pushes it through |
|---|---|---|
| Material | It would affect the price, or a reasonable investor would want it | Specific, reliable source, clear price effect |
| Nonpublic | It has not been made available to the market in general | Told to a few analysts or a closed group: still nonpublic |
Memory hook Two gates, both must be open. Material AND nonpublic: freeze. Either one closed: the Standard does not bite.
Know it cold Both gates open: do not act, do not cause others to act (no trading, no tipping, no hinting through changed recommendations).
MemorizeIf you receive it
| Step | Action |
|---|---|
| 1 | Do not trade and do not alter recommendations |
| 2 | Encourage the issuer to make it public |
| 3 | If it cannot be made public, tell only supervisory and compliance staff |
Memory hook Freeze, push it public, tell compliance. Never "publish it yourself" or "tell big clients".
Know it cold Firewall: compliance clearance of cross-department talk, watch / restricted / rumor lists, documentation, heightened proprietary-trading review; plus physical separation and no personnel overlap.
- Material and nonpublic Memorize both gates open
- Do not act or cause others to act no trades, no tips
- Encourage public disclosure then tell compliance if it cannot be made public
-
- Material but public Memorize already disseminated
- Free to use II(A) no longer applies
-
- Nonpublic but not material Memorize small details
- Mosaic theory may be combined with public facts into a conclusion
-
- Compliance clearance Memorize cross-department communication goes through compliance or legal
- Lists Memorize watch, restricted and rumor lists to review employee trading
- Physical separation Memorize banking away from sales and research
- No personnel overlap Memorize an employee is on one side of the wall at a time
- Documentation and proprietary trading review Use it record the controls; restrict firm trading while holding inside information
How it is asked
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Overheard or accidental, then trade
An analyst overhears executives discussing an unannounced dividend cut and sells for clients. Violation?
Yes, II(A). How you got it does not matter. Trap: "she did not seek it out".
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Mosaic or tip?
Parking-lot images, public filings and supplier chats lead to a downgrade. Violation?
No, mosaic theory. Trap: "the conclusion is material".
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Most appropriate first step
Investor relations officer slips an analyst a nonpublic earnings result. First step?
Do not trade; encourage public disclosure; tell compliance. Traps: publish it, give it to big clients.
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Which procedure?
Which control best keeps banking deal knowledge away from research?
Firewall with compliance clearance, lists, separation and no overlap.
Exam traps
- Treating information given to a few analysts as public. It stays nonpublic until it reaches investors in general.
- Calling the mosaic theory a violation because the finished conclusion would be material.
- Thinking only trading is banned. Tipping others, or changing a recommendation on the information, is covered too.
- Thinking it matters how you got the information. Overheard, accidental or deliberate, you may not act.
- Believing a respected analyst's published report breaches II(A) because it moves prices. It comes from public information and expertise.
Checkpoint
3 exam-style questions. About 90 seconds each.
1An analyst overhears two executives on a train discussing a planned, unannounced dividend cut at their company. The analyst sells the stock for clients before the announcement. Did the analyst violate the Standards?
2An analyst combines public satellite images of parking lots, public filings and conversations with suppliers about general industry demand, concludes that a retailer will miss earnings, and downgrades it. Did the analyst violate the Standards?
3An analyst inadvertently receives material nonpublic information from a company's investor relations officer. The analyst's most appropriate first step is to:
Key takeaways
- Material and nonpublic: do not act and do not cause others to act.
- Mosaic theory: public facts plus nonmaterial nonpublic pieces are fine, so keep records of how you got there.
- If you receive inside information: do not trade, encourage public disclosure, tell compliance.
- Firewalls, lists, separation and no overlap prevent misuse inside multiservice firms.
All Ethical and Professional Standards formulas, every lesson
Practice exam-style questions on Guidance for Standard II: Integrity of Capital Markets
Questions about this lesson?
Where this comes back
- Standard II(B): Market Manipulation Guidance for Standard II: Integrity of Capital Markets
- How to answer Ethics vignettes: a five-step method Ethics Application
Questions candidates ask
What is material nonpublic information?
Information that would affect an investment's price or that a reasonable investor would want, and that has not been made available to the market in general. Both conditions must hold. A specific, reliable source makes materiality more likely.
What is the mosaic theory?
Analysts may reach conclusions by combining public information with nonmaterial nonpublic details, even if the conclusion would be material if the company had announced it. Keep records of the research so the method can be shown.
What should I do if I receive inside information?
Do not trade or change recommendations. Encourage the company to disclose it publicly. If it cannot be made public, tell only your supervisor and compliance, and act on it only once it is public.
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